The country pulled together to fight in WWII - stimulating economic growth

When we study the Great Depression, and the double dip recession of 1937-38, the class discussion inevitably ends up with the role that World War II played in bringing an end to a decade’s worth of poor economic performance. Which leads us to the question – is going to war good for economic growth, and if it is should we adopt war as an economic growth strategy?

The simple answer is, “no” -  war just diverts a nation’s scarce resources from one activity to another. Even if some resources are idle, the gain is short-lived and a poor investment in long term growth. (Think of a tank burning in the Iraqi desert versus a fleet of trucks hauling freight for 20 years.) In the case of the Depression and World War II, the threat of Nazi Germany and, later, Japan, gave Congress and the President political cover to use deficit spending which in turn stimulated the economy. Ultimately, though, the country’s economic growth came from private investment and private demand after the war.

No worries about the government borrowing money (through the sale of bonds) in the face of an enemy

This brings us to the “Broken Window Fallacy”. With a hat tip to econ major Ryan Chaddock, there’s a nice summary of this parable here. The fallacy poses a similar question – should we go around breaking windows in order to generate more work for glaziers?

Bastiat’s point, in a way, is about opportunity cost- unless resources are idle, they must be shifted away from one activity in order to be shifted toward another.

[...] Even if breaking the window were to increase production in the short run, the act cannot maximize capital or wealth in the long run simply because it will always be better to not break the window and spend resources making valuable new stuff than it is to break the window and spend those same resources replacing something that already existed.

photo credit to Xavier Encinas on Flickr

Milton Friedman used it as the title of a book. Wikipedia reports a varied and uncertain past for the phrase. As economists we look at the statement as rather obvious – converting negatives to positives – everything has a cost. Classical economics begins with the idea that there are scarce resources that help improve our lives or our country or the globe and that those resources are insufficient to meet all of our needs – hence the adjective scarce. There are fresh, new discussions on the possible inadequacies of this foundation principle in classical economics, but I believe it serves us well.

My challenger listed several examples of “free lunch”, including open source software and Google services. So do these examples provide a robust exception to the No Free Lunch proposal? I say “no.”

Every choice we make involves opportunity cost. When I choose an object or an activity that has no monetary price I am still choosing it over something else. If I choose to download OpenOffice, supported now by the Oracle Corporation, I devote some additional room on my hard drive to the application, which could have been used for something else. I start using this to compose or read documents, instead of using a commercial product like Microsoft Office. Choosing OpenOffice means giving up some features or other characteristics of Microsoft Office that I might value.

Signing up for a Gmail account is also free – price wise. Still I devote precious time to setting it up – time I could have used for other pursuits. And I adapt to the idiosyncrasies of Gmail, giving up features I might have enjoyed with my Mac Mail application or features that Yahoo provides.

So, yes, daggummit, everything has a cost and there is no free lunch. The moral of the story is to remember that costs involve more than money or prices, and that opportunity costs are often the most important costs to consider.

But all these figures don’t quite get at Iraq’s real cost. Indeed, we usually don’t even frame the question the right way. We’d do better to recognize what we’ve lost, rather than focusing only on what we’ve paid.

We often think of cost simply in terms of dollars spent, but the real cost of a choice — what economists call its “opportunity cost” — consists of the forgone alternatives, of the things we could have had instead. For instance, the cost of seeing a movie is not just the dollars you plunked down for the ticket, but also the subtler cost of missing a dinner at home or a cocktail party at work. This idea sounds simple, but if applied consistently, it requires us to rethink and, yes, raise the costs of the Iraq war.

Let’s use an example that most of us will recognize. Let’s consider that time is a scarce resource. We value time, we always would like more of it, and we often don’t have enough of it. We have to decide how to allocate our scarce supply of time among various activities – including studying, sleeping, working, eating, and recreation. So time is the scarce resource, and we make various decisions on how to allocate time among competing uses.

So, what’s another scarce resource for most of us? How about money? With some pretty rare exceptions we don’t have enough of it – so it is scarce. Every day we make decisions about how to use, or allocate, the little bit of money that we have.

Now, let’s broaden our perspective just slightly. Imagine you are living in a household – perhaps with a family, or a roommate, or a significant other. Your household needs more money and more time than are available, and you have the same allocation decisions to make about them. In addition, your household has only a certain amount of basic, unskilled labor. You might ask, “what does labor have to do with my home or apartment?” Well, ask that question the next time you argue about who gets to take out the trash, wash the dishes, or do the laundry. Each of those activities require fairly unskilled labor, and households with more people can divide up those tasks more easily than someone living alone. So, we have added labor to our list of scarce resources. We define labor as kind of raw, unskilled warm bodies.

What if you or someone in your household is good at fixing cars? Or perhaps one or more of you have enough experience to be hired out as a food waiter? In each case, the concept of unskilled labor is being embellished, based on some skills, knowledge, or experience you might have. Can you see how a household which holds more of those skills or knowledge has a greater store of this important scarce resource?

When we were thinking about time as a scarce resource, we understood that there are a number of different ways to use time. Let’s pick two – studying for class or having fun. Let’s say it is Thursday evening, the weekend is less than a day away and you have to decide whether to study for economics or go see a movie.

If you decide to stay home and study there are some benefits that come from that decision – hopefully a better grade. And yet, if you decide to study it means you are giving up a fun evening at the movies with friends. Your decision to study brings with it a cost – that you have to give up something you would have enjoyed. We call this opportunity cost.

Opportunity cost is a crucial concept in economics and it guides much of the decisions we make. Robert Frost wrote about choices:

Whatever path we take, and the benefits that come from that choice, there is always a cost in terms of the benefits we will not get to enjoy from going the other way.

Take a second right now to think of some decision you typically make. Perhaps it is what to do this evening. Or maybe you need to decide how to spend the $10 left in your pocket. Whatever the decision think about your choice, and then consider what you are giving up by making that choice. That “what you are giving up” is the opportunity cost.

One more example of opportunity cost that most of us can only dream about… Imagine that you are a superb athlete, musician, or artist. You are given the choice to continue going to school, or leaving school to turn “pro.” What is your opportunity cost if you decide to stay in school and put off your professional dreams for another year or two? In this case your “cost” of going to school another year is the money, fame, or whatever that you give up in order to stay with your studies.

Now turn the decision around. If you decide to “turn pro” what is your opportunity cost? It is the benefit you would have gotten from another year of a college education.

OK, earlier we listed some examples of scarce resources, as seen from the perspective of an individual or a household. Now let’s ask the same questions about a country, or a state.

One resource that is scarce for a country is capital. We can loosely think of this as “big money.” Now obviously a country can print as much currency as it wants. The real, scarce financial resource is capital – loaned by investors or gained through the sale and export of goods. Countries have to make some critical decisions on how to use scarce capital. Should they build roads, develop communication, build schools, or invest in developing ports? All of these require capital and there is never enough of it.

Traditionally land has been listed as a scarce resource, and that still applies today. Countries with more land have more opportunities for growth, or agriculture, or mining.

Natural resources are another key scarce resource for a country. Abundant water, healthy forests, precious minerals, and arable land all can contribute to a country’s success. Yet we often seem to not have enough of them.

And, similar to our household, labor is a key scarce resource. We still think of labor as warm bodies – no skills, just people to do simple work.

We can provide leverage for that labor, if we have more skills, knowledge, or experience. These skills are often in short supply, so they qualify as a scarce resource. Gaining more of these resources make our labor much more productive.

Let’s review the list again:
For individuals and households we have these scarce resources:

1. Time
2. Money
3. Labor
4. Skills/Knowledge

For countries we have:

1. Capital
2. Land
3. Natural Resources
4. Labor
5. Skills/knowledge

And one final thing to review – opportunity cost. Remember to think of opportunity cost in the context of a decision or a choice. Whichever choice you make you turn your back on the benefits of the choice not made – the road not taken.